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Microsoft Cloud Gross Margins Set to Improve

Amy Hood

Amy Hood

Microsoft predicts its cloud gross margins will significantly improve during the company’s fiscal year 2017 (which started July 1, 2016) — with Azure gross margins eventually matching those of Amazon Web Services (AWS). The bold prediction comes at an important time for Microsoft shareholders and channel partners.

In Microsoft’s fiscal Q4 2016 (ended June 30, 2016), commercial cloud gross margin was 42 percent — declining year over year, and down from 45 percent cloud gross margin one quarter ago, according to ChannelE2E’s records. Investments for cloud capacity, deployment, and support triggered the decline, according to CFO Amy E. Hood.

Safra Catz

Safra Catz

In stark contrast, Oracle’s PaaS and SaaS gross margins were 51 percent in the company’s most recent quarter — with CEO Safra Catz predicting gross profit margins will hit 80 percent over time.

So where does that leave Microsoft? Hood sounds confident that the company’s cloud infrastructure is now firmly in place, and margins will steadily improve over time after fluctuating a bit near-term. During an earnings call this evening, Hood said:

“We expect the Commercial Cloud gross margin percentage and dollars to materially improve next fiscal year. We have invested heavily to build share, expand geographically, and ensure world-class support and reliability for our commercial customers. Going forward, we expect those investments to provide benefits of scale. We also anticipate our cloud capital expenditure growth curve will slow. Given seasonality and revenue mix, Commercial Cloud gross margin will see variability quarter to quarter but an overall trend of material improvement. At the company level, as each cloud service continues to grow and improve its gross margin percentage, our company gross margin should only decline roughly a point in FY 2017.”

Microsoft Azure vs AWS Cloud Gross Margins

Investors quizzed Hood, asking if Azure margins could match those of Amazon Web Services. Her reply:

“I think I have a strong line of sight to AWS’s margin profile and still feel good about the progress we’re making, not just on the workloads that are relevant, apples to apples with Azure, but also in our broader cloud portfolio and our ability to have very healthy margins across Dynamics 365 as well as Office 365 in conjunction with many of the innovations we’re doing across Azure. So while I am focused on both the workload improvement, I’m also focused on what’s possible across the entirety of the cloud.”

Translation: Hood danced somewhat around the question. But read between the lines, and Microsoft is certainly aware of AWS costs and revenues, and Azure seems modeled to match the effort in the quarters or years ahead.

Microsoft Cloud Margins and Partners

Microsoft’s ability to maintain — or potentially boost — its cloud gross margins are particularly important to the company’s channel partner program, which is now led by Gavriella Schuster.

gavriella schuster

Gavriella Schuster

No doubt, thousands of partners now support Office 365 and Azure. And Microsoft’s Cloud Solutions Provider partner program has gained momentum. But Microsoft’s board of directors has spent recent months closely studying the cloud and subscription software markets — trying to determine if or how to further tweak the company’s go-to-market strategy.

If Microsoft’s own cloud margins were to further shrink, it would potentially pressure how the company compensates partners. But assuming Hood’s financial models are accurate, it sounds like Microsoft expects eventual progress and upside on the cloud gross margin front.

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